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Ten, five, even three years ago I would have, and did, make the bet that China's growth rate would outperform India's. Today, I would have to be more circumspect. My bet is that India will begin to outperform China within the next five years. What accounts for this change in perspective? Sustained improvement on many fronts including the development of physical infrastructure (especially roads, ports and telecommunications), trade and tax policy reform, and the coming of age of a new generation of Indian entrepreneurial talent all add up to impressive change.

But, by far the most significant development in the Indian macro story is the declining cost of capital. It is difficult to exaggerate the impact that falling interest rates have had on the functioning of the Indian economy. Over the past three years, borrowing rates have declined by about 600 basis points for most medium to large sized enterprises in the country. Whereas such companies were paying 14 per cent on one-year loans three years ago, today they are paying only 8 per cent. Borrowing rates for some of the largest corporates are up to 200 basis points lower.

In part, the declining interest rates reflect a fall in the rate of inflation. But even in real terms, interest rates have fallen sharply. What is key is that this does not reflect merely a cyclical adjustment, although that is part of the story. It is in fact largely the result of the progressive dismantling of a system of administered interest rates in the country. To be sure the system is still not fully disbanded. Rates on small savings deposits are still fixed by administrative fiat. But now there is at least greater flexibility and pragmatism in how they are set. So what we have seen is a significant structural decline in interest rates that has the potential to trigger fundamental improvements elsewhere in the economy.

First, compared to China and the rest of East-Asia in its high growth phase, India’s manufacturing sector is much smaller (16 per cent versus 35 per cent of GDP). The popular perception, until very recently, has been of an uncompetitive Indian manufacturing sector hobbled by poor physical infrastructure and rigid labour regulations. It turns out that perhaps the most serious handicap faced by Indian manufacturing has been the relatively higher cost of capital. Between 1997 and 2000 real interest rates on the average five-year loan fell from 7.8 to 4.9 per cent, whereas in India they actually rose from 6.4 to 7.8 per cent (due to a decline in the domestic inflation rate).

Since 2000, however, the trend has reversed thanks to several cuts in the administered interest rates in India. For the first time that I can remember, real interest rates in India are lower than in China. And the effects of this are dramatic.Consider the following: Every 10 per cent fall in interest rates leads on average to a 30 per cent increase in profits before tax (PBT) for larger Indian corporations. For firms in manufacturing that operate with higher levels of debt relative to the average for all companies (companies in the less asset intensive service industries can operate with lower debt-equity ratios), the impact on PBT of declining interest costs is likely to have been even larger.

Given that borrowing costs for larger corporates have fallen as much as 40 per cent in the past three years, profits before tax for these companies have more than doubled, raising returns on equity to well above the cost of capital. Suddenly, even manufacturing activity is looking like an attractive proposition in India. Second, India's predominantly state-owned banking system has been capital constrained for many years, weighed down by non-performing assets created during the investment boom following the initial years of economic reform in 1993/95. As a result banks have become risk averse tying up more than three-quarters of their balance sheets in government securities. The decline in interest rates has handed this passive banking system a salutary bonus in the form of enormous paper gains on their portfolio of government securities.
Source: Business Standard
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Claus and Edward's "Baker's Dozen"

Claus Vistesen and Edward Hugh are proud and happy to announce that they are now working as "featured analysts" with a new Boston-based start-up - Emerginvest.

Claus and Edward have used a new, updated, methodology in order to identify a group of 13 emerging economies which we consider are going to outperform both the rest of the emerging economy group and the OECD economies in terms of a number of key performance indicators over the 2008 - 2020 horizon.

Through our association with Emerginvest we hope to develop performance indicators which will confirm both the relevance and validity of the selection procedure adopted.

We would like to point out that we have absolutely no financial connection whatsoever with Emerginvest - although we do heartily endorse what they are trying to do.

In particular we see the move by the investment community towards emerging markets as one of the most effective and direct ways to address those issues of inter-country wealth and income imbalances which have plagued our planet for so long now - namely by getting the money from the rich who have it to the poor who need it.

Sending investment to emerging economies is also a way of addressing the underlying imbalances which exist between the relatively older populations of the developed economies who increasingly need to save, and the relatively younger emerging economies who can benefit from the investment of those savings in their countries. So in a way you can both ensure the future of your own pension and help attack poverty at one and the same time. This type of possibility is normally known in economics as "win-win".

The oldest known source and most probable origin for the expression "baker's dozen" dates to the 13th century in one of the earliest English statutes, instituted during the reign of Henry III (r. 1216-1272), called the Assize of Bread and Ale. Bakers who were found to have shortchanged customers could be liable to severe punishment. To guard against the punishment of losing a hand to an axe, a baker would give 13 for the price of 12, to be certain of not being known as a cheat. Specifically, the practice of baking 13 items for an intended dozen was to prevent "short measure", on the basis that one of the 13 could be lost, eaten, burnt or ruined in some way, leaving the baker with the original dozen.

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About Claus

Claus Vistesen is a 23 year old macroeconomist who is on the point of finishing his MSc in Applied Economics and Finance from the Copenhagen Business School. His primary research interests are international finance and international macroeconomics. Claus is especially interested in how the changing structure of global and national demographics impacts on local macroeconomic performance. Moreover - and as the wonk he ultimately is - he also takes a considerable interest issues and methodologies associated with econometrics, and this is an interest he intends to develop in his postgraduate research.

About Edward

Edward 'the bonobo' is a Catalan macroeconomist and economic demographer of British extraction, now based in Barcelona. By inclination he is a macroeconomist, but his deep-seated obsession with trying to understand the economic impact of contemporary demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

He is currently working on a book with the provisional working title "Population, the Ultimate Non-renewable Resource".